Richard Green is a professor in the Sol Price School of Public Policy and the Marshall School of Business at the University of Southern California.
This blog will feature commentary on the current state of housing, commercial real estate, mortgage finance, and urban development around the world. It may also at times have ruminations about graduate business education.

Friday, February 09, 2007

The Wall Street Journal in the past few days has featured stories about the troubled subprime mortgage industry. There was a particularly telling graph today:

One thing about the graph that leaps out is that under all market conditions, subprime mortgages really are not just riskier and more costly, but substantially riskier and more costly than prime and Alt-A mortgages. While late payments do not necessarily lead to default (most of the time they do not), mortgages with late payment require more servicing, or individual attention, from lenders, and are therefore more expensive.

With the housing market slowing, it is also now more likely that late-payment mortgages will eventually go into default; this is the reason HSBC has had to set aside $10.5 billion reserves for potential sub-prime mortgage losses. To place this in context, HSBC earnings are about $15 billion per year.

Advocates worry that subprime borrowers pay too much for mortgages. While there are doubtless borrowers in the subprime pool who qualify for prime mortgages, and who should be encouraged to use the prime market, as a group, subprime borrowers are riskier. The data from the past few days suggest that it is possible that the mistake some lenders made was not charging too much, but rather not charging enough.

The data also suggest that for many borrowers, the absence of a subprime market would produce an absence of opporuntity for any mortgage.